The Stern Files (fifth edition)

It is a new year, and it is still unclear what long-term consequence the Supreme Court’s decision in Stern v. Marshall, 564 U.S. 2 (2011) will have for the jurisdiction and authority of the bankruptcy courts. We are starting, however, to see Stern and the issues it presents make their way into more decisions on the circuit level. Thus, by the end of 2012 we may have a better idea of what, if any, long-term effects Stern will have on the bankruptcy courts. For a review of some of the more significant decisions stemming from Stern previously reported on, please see our earlier editions of the Stern Files.

We summarize nine recent decisions that have grappled with the Supreme Court’s holding concerning the constitutional limitations of bankruptcy court jurisdiction in this post, our fifth edition of the Stern Files:

Background: Postconfirmation, a litigation trustee brought a complaint against defendants for breach of fiduciary duty and allegedly fraudulent transfers. The parties agreed that that the complaint alleged “a mixture of core and non-core claims all arising from the same facts.” The defendants sought to withdraw the bankruptcy reference arguing that they were entitled to a jury trial, which a bankruptcy court cannot hold absent all parties’ consent, and citing Sterngrounds because the trustee’s claims were a mixture of core and non-core claims.Stern Impact: The district court withdrew the reference for the fraudulent transfer actions that involved both core and non-core claims, holding that such withdrawal promotes uniformity and efficiency because (i) it would prevent the same issues from being litigated twice and prevent judgments from being subject to collateral attack, (ii) decisions on matters core and non-core alike would come from one court, and (iii) withdrawal would promote uniformity by eliminating the risk of the irrational outcome that would result “if the Bankruptcy Court found a certain fact relevant in both a core and non-core claim, but [upon review the district court] found that fact to be erroneous, though not clearly erroneous, the [the district court] would be required to accept that fact for the core claim and reject that fact for the non-core claim.”

Background: Defendants in an adversary proceeding brought by a chapter 7 trustee sought a determination of whether a claim for equitable subordination was core or non-core.Stern Impact: The court held that the equitable subordination claim was core after a lengthy discussion of Stern, from which the court concluded that, from a statutory perspective, all matters “arising in” or “arising under” title 11 are core matters upon which bankruptcy courts may issue a final order, and if matters do not “arise in” or “arise under” title 11, they are “related to” matters, which the bankruptcy court may only propose findings of fact and conclusions of law. The court held that Stern did not disturb this essential distinction. Thus, the court, noting that equitable subordination is “a substantive right provided by title 11,” held that such a claim is statutorily core.

Background: Plaintiff brought a state court action against defendant for fraud, fraudulent inducement, and violations of the Texas Deceptive Trade Practice Act. Defendant subsequently filed for bankruptcy protection, and plaintiff initiated an adversary proceeding in the bankruptcy court alleging similar claims to those which it had asserted in the state court action, in addition to claims of nondischargeability. Defendant asserted that the bankruptcy court lacked subject matter jurisdiction over the proceeding based on Sternbecause plaintiff never filed a proof of claim in defendant’s underlying chapter 13 case.Stern Impact: The court stated that Stern did not raise issues of subject matter jurisdiction, but, rather, addressed a bankruptcy court’s constitutional authority to enter final judgments. The court went on to hold that plaintiff’s failure to file a proof of claim wasn’t an impediment to the bankruptcy court having final authority, because the filing of the adversary proceeding constituted an informal proof of claim. The court noted that the questions before it were (i) was a debt owed to plaintiff under state law, and (ii) if a debt was owed, was the debt dischargeable? The court held that under the “public rights” exception discussed in Stern, the bankruptcy court had the authority to liquidate state law claims that were “closely integrated” with the Bankruptcy Code, and because dischargeability of debt is a question fundamental to the Bankruptcy Code, the court concluded that it had the authority to both liquidate and determine whether plaintiff’s claim was excepted from defendant’s discharge.

Background: Two groups of debtors filed class action lawsuits against a medical provider that had filed proofs of claims in the debtors’ bankruptcy cases which revealed confidential medical information on the debtors. The causes of action arose under a Wisconsin statute allowing individuals to sue when their health care records are disclosed without their permission. The bankruptcy judge granted summary judgment in favor of the medical provider, and the Seventh Circuit Court of Appeals granted direct appeal. Arguments were held prior to the Stern ruling, but following Stern, the Seventh Circuit sua sponteordered supplemental briefing on whether the bankruptcy court had constitutional authority to issue final judgments dismissing the debtors’ complaints, and depending on the answer to that question, whether the Seventh Circuit has authority under 28 U.S.C. § 158(d)(2)(A), or any other provision, to grant direct appeal.Stern impact: The Seventh Circuit stated that, although the grant of appeal appeared to be proper when granted, following Stern, that its basis for appellate jurisdiction was now in question because the bankruptcy court may not have had jurisdiction to enter a final order on the matter. The Seventh Circuit stated that Stern held that the responsibility for deciding suits made “of the stuff of the traditional actions at common law . . . rest[s] with Article III judges in Article III courts,” and, unless a claim involves a “public right,” Article III “prohibit[s] Congress from giving bankruptcy courts authority to adjudicate claims that [go] beyond the claims allowance process.” Although the Seventh Circuit found that the debtors’ claims were core because they arose in the bankruptcy case and would have no existence outside of bankruptcy, the Seventh Circuit determined that the bankruptcy court, nonetheless, did not have the constitutional authority to enter a final judgment on the debtors’ claims, because they involved a private matter of “the liability of one individual to another” that “owe[d] its existence to Wisconsin state law and [would] not necessarily [be] resolve[d] in the claims allowance process.” Thus, the Seventh Circuit held that “[w]ithout a final judgment we lack a statutory basis for appellate jurisdiction” and that is must therefore dismiss the appeals before it.

Background: A liquidating trustee brought a complaint against defendants for, among other causes of action, state law causes of action to enforce a pledge and to recover fraudulent transfers and voidable preferences. The trustee alleged that the cause of action seeking enforcement of the pledge was a core matter and sought a final money judgment. Two years into the proceeding and after summary judgment motions had been field and argued, the court asked whether the parties would consent to entry of a final judgment by the bankruptcy court. The defendants consented, but the trustee did not.Stern Impact: The bankruptcy court found that the state law action to enforce a pledge was a non-core “related to” cause of action, but nonetheless held that it had authority to enter a final judgment because the trustee had implicitly consented when he (i) filed the complaint in the bankruptcy court, (ii) alleged that all causes of actions were core, and (iii) sought entry of a final judgment in the bankruptcy court. Moreover, the court held that the trustee was estopped from withdrawing consent more than two years into the case. Thus, the court held that, under Stern, the bankruptcy court could enter a final judgment on the “related to” state law action seeking enforcement of a pledge.The court went on to note that some might see a “gap,” following Stern, where the bankruptcy courts have express statutory authority to enter final judgment with the parties consent on non-core matters under section 157(c)(2), but don’t have the same express statutory authority with respect to core matters (such as the fraudulent transfer actions in front of the court). The court held that such a gap is “logically and appropriately . . . filled by judicial extension of section 157(c)(2).” Thus, because the parties had consented to the entry of final judgment on the non-core claims, that consent was logically extended to the core matters as well.

Background: A chapter 7 trustee brought an action against the IRS to recover fraudulent transfers under section 548 of the Bankruptcy Code and under the strong-arm powers of section 544, alleging that the debtor made payments in satisfaction of its owner’s personal tax liability. Following Stern, the IRS objected to the treatment of the matter as “core” and asserted that the bankruptcy court lacked constitutional authority to enter a final judgment.Stern Impact: The court noted that Stern raised two questions: (i) whether the action at issue stems from the bankruptcy itself and (ii) whether the claim would necessarily be resolved in the claims allowance process. The court held that “the answer to the question –whether the action stems from the bankruptcy itself-is decidedly ‘yes.’” Although the court acknowledged the Stern Court’s discussion of the Granfinanciera decision, it held that “[t]his Court’s job is not to extend Stern to fraudulent transfer actions based on Supreme Court dicta, and in so doing, upend the division of labor between district and bankruptcy courts that has been in effect for nearly thirty years.”The court went on to note that, even if it were determined that it lacked authority to enter final judgment, the IRS had explicitly and impliedly consented to the bankruptcy court’s resolution because the IRS had litigated the case for over a year and its only previous challenge to the court’s jurisdiction had been based on sovereign immunity.

Background: During its dissolution proceeding (but prior to its bankruptcy filing), Heller Ehrman agreed to waive its rights to recover fees associated with unfinished business the law firm had been handling at the time of its dissolution, which former partners had taken to other law firms. Postpetition, however, Heller Ehrman sought to avoid these waivers as having constituted actual or constructively fraudulent transfers under section 548 and 550 of the Bankruptcy Code and under California state law. A group of defendants moved to withdraw the reference asserting that the bankruptcy court lacked authority to enter final judgment on the claims.Stern Impact: The district court, focusing on Stern’s analysis of Marathon and Granfinanciera, held that “since the state law counterclaims at issue were not ‘public rights,’ their final adjudication could not be assigned to an Article I bankruptcy judge.” Nonetheless, the court held that withdrawal of the reference was not required in the present case because the bankruptcy court could still enter a report and recommendation. The court also held that permissive withdrawal, similarly, was improper because the bankruptcy court was familiar with the case, and, thus, allowing the action to proceed before the bankruptcy court would allow for efficient and uniform administration of the bankruptcy case.

Background: Plaintiffs provided financing to entities that later commenced chapter 11 cases in the bankruptcy court for the District of Delaware. After the commencement of the chapter 11 cases, plaintiffs filed an action in Texas state court for fraud and negligent misrepresentation against certain officers and directors of the debtor. The officers and directors removed the action to federal court, and the plaintiffs moved for remand for lack of subject matter jurisdiction. The officers and directors responded by filing a motion to transfer to Delaware federal court.Stern Impact: The court held that Stern “negates the presumption that a ‘related to’ proceeding can be more easily, expeditiously, and inexpensively tried in front of the home bankruptcy court.” Additionally, the court held that there was little question that a bankruptcy court would lack constitutional authority to hear the state law causes of action between nondebtors that did not stem from the bankruptcy proceeding and would not be necessarily resolved by the claims allowance process. Thus, the court held that transfer was inappropriate and remanded the case to the Texas state court.

Background: A debtor entered into settlements in two shareholder derivative class actions suits brought against the debtor and its officers and directors that were filed prior to the commencement of the debtor’s chapter 11 case. The bankruptcy court entered an order approving the settlement pursuant to Bankruptcy Rule 9019 over the objection of a claimant. On appeal of the bankruptcy court’s order, the claimant asserted that the bankruptcy court did not have constitutional authority to resolve the shareholder derivative claims following Stern.Stern Impact: The court held that the “full reach of Stern has yet to be determined, but it is clear that the case does not implicate the approval of settlements, relating to property of the debtor’s estate, under Rule 9019.” The court, citing In re Wash. Mut., No. 08-12229 (MFW), 2011 WL 4090757 (Bankr. D. Del. Sept. 13, 2011) noted that there is a “fundamental difference between a court’s entry of a final, binding judgment on the merits of a claim and its approval of a settlement of that claim.”